Mortgage Priorities After Loan Modification: Contract Language Matters!
It is common for real estate to be encumbered by more than one mortgage or deed of trust. Contexts vary greatly, from construction loans to borrowers just wanting to pull out equity using a home equity line of credit or traditional second mortgage. In most situations, there is little question about which lender or lienholder has priority over the other. The earlier mortgage normally has priority over a later one. However, things get more complicated when the amount of a senior mortgage increases after a later mortgage has come along. Deeds of trust often provide that they secure a promissory note in a certain face amount, as well as any modifications or future advances under the note. If a junior lender makes a loan based upon the perceived equity in property left after taking into account the original face amount of the senior lender’s recorded deed of trust, disagreements can arise later as to the extent of the senior lender’s priority. The senior lender may feel it should have priority because the recorded deed of trust put any future lenders on notice that the secured loan balance could increase, whereas the new lender may feel that is unfair because the new lender should not have been required to assume that the original loan amount would increase. This debate over the proper lien priorities in this situation has raged for a long time, and has not been fully settled under Washington law until a recent Washington Supreme Court decision in June 2022 (see below).
The majority of American courts traditionally took the view that the question of lien priority, for a senior lender who increases the secured loan amount with modifications or future advances, should depend upon whether the senior lender’s advances were optional or obligatory under the terms of the loan. If they were obligatory (meaning the lender was contractually obligated to loan additional amounts), then the future advances have the same priority as the original loan, but if they were optional (i.e., the senior lender had discretion to deny a future advance), then the increased amounts would only have priority as of the date of the modified loan/deed of trust. But other courts and commentators have opined that where a future advance clause appears in a senior lender’s recorded deed of trust, the future advances always have priority over the junior lender, regardless of whether such advances were optional or obligatory.
In 1991, the Washington legislature enacted RCW 60.04.226, which provides that a mortgage or deed of trust has priority over any later “liens, mortgages, deeds of trust, and other encumbrances which have not been recorded prior to the recording of the mortgage or deed of trust to the extent of all sums secured by the mortgage or deed of trust regardless of when the same are disbursed or whether the disbursements are obligatory.”
In June 2022, in the case of Commencement Bank v. Epic Solutions, Inc., our Supreme Court considered the scope of RCW 60.04.226 and the common law regarding lien priority of future advances. In that case, a senior lender’s deed of trust provided that it secured payment of a certain amount according to a promissory note, along with “all renewals, modifications or extensions thereof, and also such further sums as may be advanced or loan by “ the borrower. A second lender recorded a deed of trust on the property for $1.5 million, and the first lender subsequently modified its original loan and deed of trust, later claiming that its lien was several times the original amount. The first lender claimed that under RCW 60.04.226 and another case, the modifications and later advances automatically had priority over the second lender. On its face, the statute may appear to apply to all loans. However, because it was enacted as part of the law on mechanic’s liens, Commencement Bank held that it applies only in the construction context, and has no application for lien disputes between mortgage lenders outside of construction. Furthermore, the Supreme Court declined to adopt certain provisions of the Restatement (Third) of Property: Mortgages, and held that common law principles apply outside of the construction context: If a future advance clause requires the senior lender to lend more money in the future, then such advances enjoy priority over later liens, but where such advances are merely optional, they have lower priority than the intervening junior lienholder. Notably, Commencement Bank declined to decide whether future advance clauses must specify maximum loan amounts, leaving for another day how that question might ultimately be resolved. The court remanded the matter to the trial court to determine the existence of a contractual provision between the senior lender and the borrower concerning future advances, and whether it was optional or obligatory.
Some of the main takeaways from Commencement Bank include: (1) Senior lenders and their borrowers should carefully consider the language in their trust deeds and loan agreements, to make clear whether future advances will be mandatory or contingent; and (2) Junior lenders should carefully analyze senior deeds of trust to confirm whether the trust deed secures future advances. If so, the junior lender needs to inquire concerning the terms of the future advances to determine whether the junior lender’s lien will or will not have priority. Not checking can have dire consequences and leave a junior lender at much greater risk of being undersecured and ultimately unable to collect on their loan.
The lawyers at Beresford Booth have a wealth of experience advising borrowers and lenders, both in the transactional and dispute context. We would be happy to assist you. Please contact Beresford Booth at info@beresfordlaw.com or by phone at (425) 776-4100.